Depression, Fed policy find uneasy equilibrium

Kirk Spano, the winner of the first MarketWatch competition
to find the world’s next great investing columnist, is a registered investment
advisor and founder of Bluemound
Asset Management, LLC which seeks to provide investors with greater safety,
growth, income and freedom. Kirk’s biography and various business endeavors can
be found at KirkSpano.com. Follow Kirk on
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I took a walk down memory lane in my last article, and thought I'd continue the stroll today for a bit longer today.

A few years ago a friend of mine, the CEO of a local company, said that the monetary policy of the Federal Reserve was unnecessary because we were "in a garden-variety recession." Things were doing pretty good for his company at the time and still are, but from what I can tell, that's more due to him and his staff than the economy.

As my last column pointed out, I maintain that we are in a depression. This depression started much like the Great Depression, with a massive collapse of financial markets. The collapse has been followed by high unemployment and underemployment, again similar to the Great Depression. Aggregate demand has fallen off as a result and is unlikely to rebound soon due to demographic factors and persistently high debt.

However, there is one major difference between the depressions. Unlike the Great Depression, this depression is marked by extremely accommodative monetary policy. Helicopter Ben has delivered and he has had backup from other central banks. As a result, money supply and monetary base have increased dramatically in the United States and abroad.

"How much would you pay to avoid a second Depression?"
—Ben Bernanke

It is particularly interesting that emerging-market economies have also largely loosened monetary policy in an effort to match U.S. depreciation and maintain their export economies. Several emerging nations have complained about U.S. monetary looseness, particularly Brazil, due to inflationary pressure that they pin on Fed policy. Chairman Bernanke has responded that emerging economies ought to let their currencies appreciate.

This is a new circumstance that many emerging economies are using countercyclical monetary policy to manage their economies. In past downturns, emerging economies have generally had to defend their currencies to maintain stability. This circumstance, in addition to the well-publicized "flight to safety" trade which occurs when fear levels rise, is likely a reason the dollar has remained firm despite inflationary policies by the Fed.

The net result has been that nominal values of assets have increased on many markets, including American, without real economic growth. The growth we have seen has almost entirely been driven by the creation of more money. At some point, the prolific money creation will have to come to an end. We know that. What we do not know is what happens when the music stops. While we wait, we have found some sort of uneasy equilibrium where assets continue to drift upward and volatility remains relatively low.

Looking at American banks yields some clues as to when the money song will end and we will forced to fend for ourselves more naturally. Wells Fargo and US Bank are standing on relatively stable ground with very manageable nonperforming assets. Bank of America, on the other hand, still has the Countrywide mess to clean up. That is probably the biggest cleanup still going on, though Citigroup has quite a bit of work to do as well.

In talking to people in the banking industry, they all say that the majority of the excess foreclosure process should end by about 2014. It is important to know they also told me 2012 several years ago and 2013 two years ago.

The cleanup depends largely on when the job situation starts to reverse more firmly. I would anticipate that the "mostly clean" year is pushed out another year or two, possibly longer. I also anticipate at least one or two more years this decade that home prices and commercial prices decline a bit. This will be the year that we have a recession, quite possibly 2013 or 2014.

As a result of the unusual combination of real-estate weakness and cheaper money, I have told qualified folks who might like to own more real estate to save cash for it rather than pump money into retirement plans in the short-term. For those who don't have the acumen or desire to own real estate, there are some bank surrogates to invest in. Wells Fargo is one of the best according to Warren Buffet. I buy it on dips. There are several regionals that appear to be strong bets as well.

Whenever I talk about the depression, people ask me why buy anything at all. I have a simple answer. It won't last forever. Ultimately, global demand for higher standards of living and the paradigm shift — the real one — of the U.S. getting freedom from OPEC will drive real economic growth. The United States, and other resource-rich nations, will begin to do very well again when that occurs later this decade. Use the coming final corrections of the secular bear market to accumulate valuable long-term assets.

Disclosure: Kirk Spano and/or clients of Bluemound Asset Management, LLC own shares of Wells Fargo. Neither Kirk nor Bluemound clients plan any transactions in the next three trading days. Opinions subject to change at any time without notice.

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